Social Security 666 Essay, Research Paper

Should Social Security be Privatized?

Many people don?t understand how the Social Security system really works. There are no separate Social Security “accounts” set up for each taxpayer to which he contributes his Social Security “tax” each year. Many people believe these accounts exist, that the money they pay into their accounts grows each year until retirement, and when they retire they get back what they paid in with interest. This is not true. Most people are unaware of the fact that our current Social Security system is a “pay-as-you-go” program, which means that the revenue the federal government raises each tax year for Social Security benefits is paid out that same year to beneficiaries. Many economists believe that our Social Security system is in need of a major overhaul if today’s workers are to receive future benefits. Thomas R. Saving, Director of the Private Enterprise Research Center at Texas A&M University says, “What is wrong is that the Social Security system was never set up to be a sound investment-based retirement system.”

Karl Borden, professor of financial economics at the University of Nebraska recently wrote, “Social Security is an unfunded pay-as-you-go system, fundamentally flawed and analogous in design to illegal pyramid schemes. Government accounting creates the illusion of a trust fund, but, in fact, excess receipts are spent immediately.”

Robert M. Ball, former commissioner of Social Security said, “Some of the trust fund money should be put into the stock market. I want to do it to get a better return for the Social Security system. Historically, long-term government bonds have had a real return, after inflation, of 2.3 percent a year, compared with 6.3 percent for stocks.”

Paul W. Boltz, economist for the T. Rowe Price mutual fund said, “When we examine the pending financial crisis of our Social Security system, we find, in effect, the characteristics of a government sponsored Ponzi-type scheme.”

Michael H. Cosgrove, of the Dallas-based newsletter, The Econoclast says, “People need to take the responsibility of investing their own funds for their retirement. The Social Security system assumes people can’t make that decision and government can do it better. The result is a bankrupt Social Security System.”

These economists believe that by investing in the private market, someone currently entering the labor force and retiring at age 65 can expect to receive an inflation adjusted retirement benefit from 1.5 to 5.5 times the current social security benefit.

Increasing life expectancy and decreasing birth rates have combined to create the crisis the system is now facing. For example, in 1950 there were 16 workers for every social security retiree, while presently there are only 3.3 workers for every retired worker drawing benefits. Estimates are that by 2030 there will be fewer than two workers for every retiree. Privatizing social security sounds extreme, but it has been done successfully in other countries like Chile. Jose Pinera, who was Chile’s minister of labor, privatized the state pension system in 1981. It is now giving retirees generous pensions while fueling investment, growth and improving living standards in that country.

The heart of the Chilean system is a mandatory savings plan. All workers under age 45 contribute 10 percent of their monthly earnings in special accounts, known as AFPs (Administradoras de Fondos de Pensiones). Workers between ages 45 and 65 could shift to the new system at their option. The funds in AFPs are professionally managed and invested in stocks and bonds. The money may not be touched until retirement, at which time the worker may begin phased withdrawals or purchase an annuity. At the end of 1995 more than $25 billion was invested in AFP accounts. The old Social Security system is being phased out. By 2030 Chile’s Social security will entirely be privatized.

This system ensures the money a taxpayer pays for retirement goes to helping that taxpayer retire (not others). It ensures the money paid in taxes is invested and grows. It also gives taxpayers choices over their plans and the age at which they want to retire. If the US were to adopt a system like Chile’s, we could save our own failed Social Security system and provide real security and peace of mind to everyone. The money paid into these individual retirement accounts is invested, meaning more capital is available to the business sector for investment. An individual would have their very own pension, with their name on it. The government would no longer control the money that the individual paid in to it. It is the individual’s account, just like an IRA. It is essentially a government mandated IRA. Only difference is your tax payment goes into an individual?s account instead of going to the government. Your income would not change because you already pay the tax. You would simply redirect the payment into an IRA. People would be living off their investment income and not a transfer payment funded through economic growth-slowing taxes. The government would only need to cover those people whose pension did not provide an adequate income. This would be a much lower percentage than the current system of near 100 percent.

Politicians have been extremely reluctant to change Social Security because any misstep could provoke explosive reactions from the program’s 43 million beneficiaries. Even Ronald Reagan at the peak of his popularity pledged a defense of the present public system and in 1983 signed bipartisan legislation to shore it up.

But this year the issue has surfaced in political debates. It provoked a bitter exchange between the two candidates for the Republican presidential nomination, Steve Forbes and Sen. Bob Dole.

When Forbes suggested that a part of younger workers’ payroll taxes go into private retirement accounts, Dole ran television advertisements denouncing the idea as “a radical untested plan that would end Social Security as we know it.” But since then Dole has expressed interest in the idea. Since the creation of Social Security in 1935, money paid into the program has been invested exclusively in interest-bearing government securities, mainly long-term bonds. But you could obtain a higher return on investment and increase retirement savings for the baby-boom generation by channeling some of the money into the stock market. But there are many questions such as: How much Social Security revenue should be invested in stocks? Who would manage the investments? How many private investment options should be allowed? Economists also disagree on how stock markets might be affected by the infusion of huge amounts of money. The financial services industry would presumably benefit, but banks, mutual funds and insurance companies have just begun to study the issue. In a Ponzi scheme, money from new investors goes out to satisfy claims of early investors. What else can you call Social Security? The current retirees are paid much more than they put in, so the younger generation has to pick up the tab. The system’s funds are invested in low-yielding Treasury securities. Over the last 50 years, such investments have returned 5.8 percent a year, while the Standard & Poor’s 500 has provided 11.9 percent.

In 1994, a poll was published indicating that more people in their twenties believed in UFOs than in Social Security. Many simply do not believe there will be anything in Social Security when they retire. A Wall Street Journal/NBC News poll showed that 29 percent of all Americans now expect to receive nothing from Social Security when they retire. Another 37 percent expect to get sharply reduced benefits. Among those under age 35, nearly half expect nothing whatsoever from Social Security. Unfortunately, there is good reason for skepticism. According to the latest report from the Board of Trustees of the Social Security Trust Funds (OASDI), Social Security tax revenues will be insufficient to pay current benefits as early as the year 2013. By 2020 tax revenues plus interest on the Trust Funds will no longer be adequate to pay for promised benefits. As more and more of this generation reaches retirement age, Social Security expenditures rise sharply. By the year 2030, Social Security outlays will have completely exhausted the Trust Funds and current revenues will be short of expenditures by about 2 percent of the annual gross domestic product. In order to meet such expenditures without cutting benefits, the Trustees estimate that the payroll tax would have to rise from the present 12.4 percent (half on employer and employee) to 19 percent. In a recent Cato Institute paper, William Shipman of State Street Global Advisors estimates that a worker born in 1970, investing all of his or her payroll taxes in stocks, would be able to retire in 2035 on $11,729 per month (in 1995 dollars), compared to an estimated Social Security benefit of $1,908. For this reason, there is a growing consensus that at least for younger workers there needs to be an alternative to Social Security. This would necessarily require some movement in the direction of privatization. Rep. John Porter, R-Ill., and Sen. Bob Kerrey, D-Neb., have suggested partially privatizing Social Security by cutting the payroll tax rate by 1.5 to 2 percentage points and requiring that the tax savings be invested in a form of individual retirement account.

The World Bank now urges developing countries to adopt Chilean-style pension systems. In a 1994 report, “Averting the Old Age Crisis,” the bank noted the positive impact of private pensions on saving, capital formation, investment and economic growth. Also, by shifting from a pension system in which people had no confidence to one that is fully funded, the effect is to actually reduce the burden of payroll taxes. Two recent studies have looked at the potential gains to the United States from switching to a private system. Harvard University Professor Martin Feldstein estimates that the value of future pension benefits would rise by 60 percent, from $11.3 trillion to $18 trillion. Boston University Professor Laurence Kotlikoff also found large potential gains in output and living standards from privatization. While everyone would be better off in the long run from a privatized Social Security system, it would cost several trillion dollars to, in effect, buy out the current generation of retirees. Thus while a private Social Security system would clearly make sense if we were starting from scratch, the cost of switching today may be too great. While the American Association of Retired Persons will no doubt fight to the death to stop privatization, in the long run its position is untenable. Social Security is going broke and will eventually be replaced with a private pension system. The sooner we at least start moving in that direction the better it will be for future generations as well as today’s economy.

Privatization does contain pitfalls. The present Social Security system is pay-as-you-go. It uses the receipts from today’s payroll taxes to finance the checks for today’s retirees. If those tax receipts were diverted to a new, privatized system, there would be an immense shortfall. The loss would have to be made up either by hiking taxes, increasing borrowing or drastically cutting benefits to current retirees. The present Social Security system faces a long-term shortfall of between 1 percent and 4 percent of total payroll, depending on your projections of future economic growth. But the existing pay-as-you-go system could be rendered solvent by a judicious combination of increasing the retirement age by two or three years and slightly raising taxes.

Also there is the question of whether to privatize the whole system, or whether to add a second tier. We might keep the basic system but supplement it

with self-directed IRA-like funds. The basic tier would be redistributive and pay-as-you-go. The supplementary layer would be private and based on individual contributions.

A further question is who bears the risk when investments go sour. There is no such risk under the current system. The stock market looks like a great retirement vehicle in the 1990?s, but it wasn’t so reliable in the 1970s and 1930s. The program was deliberately designed as a social guarantee of retirement income, not a system of government-mandated private savings